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Harry Cassin
Publisher and Editor

Andy Spalding
Senior Editor

Jessica Tillipman
Senior Editor

Bill Steinman
Senior Editor

Richard L. Cassin
Editor at Large

Elizabeth K. Spahn
Editor Emeritus

Cody Worthington
Contributing Editor

Julie DiMauro
Contributing Editor

Thomas Fox
Contributing Editor

Marc Alain Bohn
Contributing Editor

Bill Waite
Contributing Editor

Shruti J. Shah
Contributing Editor

Russell A. Stamets
Contributing Editor

Richard Bistrong
Contributing Editor

Eric Carlson
Contributing Editor

Muddy Waters: ‘Turnkey contracts well-suited to corruption’

In early December, short seller Muddy Waters published a negative report about OSI Systems, Inc., calling the company “rotten to the core.”

Muddy Waters’ main allegation was that OSI used corruption to win a 15-year turnkey security scanning contract from the Albania government worth up to $250 million.

OSI denied all allegations of corruption. The DOJ and SEC, however, launched FCPA investigations based on the Muddy Waters report.

According to Muddy Waters, turnkey contracts with governments in high-risk countries are a red flag. When goods and services are bundled, pricing becomes less transparent, and bribery is easier to conceal.

Here’s how Muddy Waters explained it in their OSI research report:

Turnkey contracts seem particularly well-suited to corruption. If a government is only purchasing scanning equipment, it is relatively easy for an internal auditor to spot an overpayment because the equipment is somewhat commoditized. However, when bundling in various bespoke services, the pricing suddenly becomes much more opaque. Given this reality, it is perhaps not surprising that the turnkey contracts to date are in jurisdictions not known for their strong governance.

In Albania, OSI formed a joint joint with a local partner to bid for the turnkey contract. The local partner is a construction company called ICMS. ICMS had been formed only eight months earlier. It was thinly capitalized with just $850, according to public records. And ICMS’s shareholder was a local medical doctor.

According to Muddy Waters, OSI (via its Albania operating company) sold a 49 percent interest in the 15-year contract to ICMS for $4.50.

OSI Systems said in response that “ICMS implemented all civil works construction for the program” and made “significant capital investments . . . well beyond the par value of shares.”

OSI also said it won the Albania contract through a public tender.

In a rebuttal, Muddy Waters said OSI provided “virtually all funding to, and investment in” the Albania joint venture. So OSI’s statement about a capital investment from ICMS is misleading.

“Even if ICMS were the greatest construction company in the world,” Muddy Waters said, “how would it be entitled to half of the economics of the concession for pouring concrete when [OSI] is providing the key equipment, technology, knowhow, and financing?”

Are turnkey contracts in high-risk countries always a problem? No. Sometimes they’re useful for fast-track projects. The government-owner can deal with one contractor. That contractor becomes responsible for assembling everything needed for the project, and for keeping the peace on the job site.

Joint ventures with local partners can also have a legitimate business purpose. Some less developed countries want to help local companies improve and grow. So the governments require foreign firms to work with local partners. Those local content laws might increase the cost of projects but in the long term, they can lead to a more diverse and vibrant local economy.

Still, Muddy Waters is right to warn about red flags. In high-risk countries, turnkey government contracts and joint ventures with local partners can camouflage corrupt deals.

We aren’t short sellers and we don’t know anyone at Muddy Waters. But they apparently understand overseas corruption risks better than some of the companies they cover.

In October 2015, Muddy Waters shorted Telia. A big reason it gave was “problematic joint ventures.”

In a 37-page open letter to Telia’s board, Muddy Waters used public records to show how Telia used joint ventures in deals with Gulnara Karimova and others.

Did the DOJ then follow Muddy Waters’ roadmap for its own FCPA investigation. Who knows?

But two years later, in September 2017, Telia agreed to pay $965 million for an FCPA settlement with the DOJ and with prosecutors in the Netherlands and Sweden.


Richard L. Cassin is the publisher and editor of the FCPA Blog.

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